June 9 (Bloomberg) -- Regulators should guard against a
repeat of the May 6 selloff in U.S. stocks by imposing limits on
how far shares can fall instead of halting trading, investors
and a former Securities and Exchange Commission economist said.

Hudson River Trading LLC, Quantlab Financial LLC, Credit
Suisse Group AG and Lawrence Harris said in comments posted on
the SEC’s website that circuit breakers proposed last month risk
making equity plunges worse. They recommended a system used on
futures markets such as the Chicago Mercantile Exchange that
subject rapidly falling securities to what are known as limit-down restrictions.

Twenty-six letters have been posted to the SEC’s website
addressing a plan to impose trading halts on stocks that rise or
fall 10 percent over five minutes, a pilot program that may
begin next week. Regulators are examining ways to slow trading
after differing rules among markets spurred a plunge that erased
$862 billion from equity value in less than 20 minutes on May 6.
SEC spokesman John Heine declined to comment.

“Halts will attenuate volatility if liquidity or
rationality arrives before markets return to operation,” wrote
Harris, now a finance professor at the University of Southern
California in Los Angeles. “Allowing markets to reverse as soon
as they are ready to do so is optimal because such reversals
restore confidence.”

The SEC said its staff is reviewing public feedback and
will present proposals to the commission this week. The circuit
breakers, which have been agreed to by executives from the New
York Stock Exchange, Nasdaq Stock Market and other venues, will
be introduced a week after they’re approved, the agency said.

Minimizing Costs

Halts “will help reduce the likelihood of this type of
unusual trading activity from recurring,” SEC Chairman Mary
Schapiro said on June 2.

A limit-down rule preventing executions below a certain
level may “minimize the costs associated with interrupting
continuous trading and denying market participants a continuous
flow of market data during critical time periods,” New York-based Hudson River and Quantlab in Houston told the SEC
yesterday. Executives at Chicago-based Allston Trading LLC and
RGM Advisors LLC in Austin, Texas, also signed the letter. The
firms are automated trading companies.

Creating price boundaries during times of volatility would
prevent transactions from occurring “outside of the acceptable
range, and ‘clearly erroneous’ trades would become a thing of
the past,” Dan Mathisson, the New York-based head of the
Advanced Execution Services unit at Credit Suisse, told the SEC
in a June 3 letter. Such rules “have been effective in
curtailing severe errors or market dislocations” in futures
trading, he said.

Additional Pilot

“There’s a lot of interest among the trading community in
a limit down,” Mathisson said in an interview. “We hope the
SEC will consider doing an additional pilot experimenting with
that mechanism as well.”

Limit-down rules are triggered on the CME when equity
contracts such as those linked to the Standard & Poor’s 500
Index fall 10 percent or more, according to the CME Group Inc.
website. They prevent trading in securities below that price
threshold, although they can still change hands above it.

Complete halts such as those envisioned in the SEC rules
for individual stocks could lead to the creation of a “fear
index,” said Harris. The number of stocks paused “will be
widely published on radio and television, and followed on real-time electronic information systems,” he said. “It will become
a focal point for fearful traders.”

Accenture’s Plunge

Accenture Plc was among stocks that plunged as low as 1
cent on May 6 as orders flowed to electronic venues with few if
any buyers. U.S. exchanges later agreed to break trades that
were 60 percent or more away from their price at 2:40 p.m., when
the selloff intensified. Transactions in 326 securities, 70
percent of them exchange-traded funds, were broken on May 6
under rules designed to curb “clearly erroneous” transactions.

The Dublin-based company filed a letter with the SEC saying
a futures-style limit-down rule might be better than a halt.

“If the most extreme prices on May 6 were caused by
momentary -- millisecond long -- gaps in liquidity, prohibiting
trading below a certain level in every stock would prevent the
aberrant trade in the first instance,” Accenture told the SEC.
If the agency opts for a circuit breaker, the firm asked for
stocks not included in the S&P 500 to be part of the pilot.

Credit Suisse and Issuer Advisory Group LLC, a Chevy Chase,
Maryland-based firm that advises companies about where to list
stock, suggested that circuit breakers in the pilot program be
in place beyond 9:45 a.m. to 3:35 p.m. since 24 percent of
trading occurs in the 15 minutes before 9:45 a.m., and the last
25 minutes of the day.

Trading Pauses

Nasdaq on June 2 said it would introduce one-minute trading
pauses on stocks listed on its market that swing over 30
seconds. The plan would supplement the market-wide circuit
breaker and follow the NYSE’s slowdown mechanisms that were
triggered 100,000 times on May 6, most for no more than a few
seconds, according to Lawrence Leibowitz, chief operating
officer at NYSE Euronext. Those measures, called liquidity
replenishment points, were implemented in 2006.

The proposed 10 percent threshold would have been triggered
at least 203 times in S&P 500 stocks and more than 10,000 times
in all exchange-listed stocks this year through May 21,
according to Knight Capital Group Inc., which filed a letter. It
warned against letting different venues adopt different rules.

“The potential exists for various venues to introduce
bespoke halts that may cause operational disruptions or
confusion among individual and institutional investors,” Knight
said. Regulators should “move carefully in allowing too many
different instances of market halts or pauses,” it said.